As a result of the uncertainty that has been
heightening both locally and globally since late
2013, Turkey’s risk premium indicators deteriorated
noticeably. In this period, exchange rate movements
and rising volatility across financial markets had
an adverse impact on the inflation outlook and
macrofinancial stability. Therefore, by the strong and
front-loaded monetary tightening implemented on
28 January 2014, the Committee aimed to control
the deterioration in the inflation outlook and to
support financial stability (Graph 4). With regard to
simplifying the operational framework, the CBRT
decided to provide liquidity primarily from the one-
week repo rate instead of the marginal funding rate
and raised the one-week repo rate from 4.5 percent
to 10 percent. In this respect, additional monetary
tightening (AMT) was terminated. The tight monetary
policy stance and the recently alleviated uncertainty
helped to contain the deterioration in medium-term
inflation expectations; reduced the financial market
volatility and slightly improved the risk premiums.

Owing to the decrease in risk premiums, the
improving global liquidity conditions, the slowing
trend of inflation and the waning cumulative effects
of exchange rate depreciation on inflation during
the second quarter of the year, the CBRT decided to
deliver measured rate cuts. Firstly, in April, the late
liquidity window lending rate was lowered from 15 to
13.5 percent. Then, the one-week repo rate was cut
by 50, 75 and 50 basis points in May, June and July,
respectively (Graph 4). In addition to the measured
rate cuts, the Committee maintained a tight monetary
policy stance by keeping the yield curve nearly flat. In
this period, the spread between 5-year market rates
and the BIST Interbank Overnight Repo rates was
lower than the average over the past years (Graph 5).

Furthermore, in order to ensure the symmetry of
the interest rate corridor, the overnight lending rate
was lowered from 12 to 11.25 percent, while the rate
on borrowing facilities for primary dealers via repo
transactions was cut from 11.5 to 10.75 percent in
August. The CBRT continued to fund the market
primarily via the one-week repo rate in the third
quarter following the decision made at January’s
interim MPC meeting that simplified the operational framework of monetary policy (Graph 6). The provision
of liquidity primarily by one-week repo auctions
enabled the CBRT average funding rate to near
the weekly funding rate. Meanwhile, in view of the
geopolitical tensions and the financial market volatility,
the tight monetary policy stance has been invigorated
by a tight liquidity policy since September. Thus, the
BIST overnight repo rates that hovered around the
one-week repo auction rate in July and August of
2014 settled close to the upper end of the interest rate
corridor in this period (Graph 4).

In order to maintain balanced growth and capital
inflows during the upcoming global monetary policy
normalization, the CBRT has changed the foreign
exchange deposit rates that apply to banks to borrow
from the CBRT within their limits through the Foreign
Exchange Deposit Market. As of 9 October 2014, the
rates for one-week maturity borrowings from the
CBRT as the last resort facility have been reduced
from 10 percent to 7.5 percent for the USD and from
10 percent to 6.5 percent for the euro. Moreover,
considering the increase in banks’ balance sheets and
the CBRT’s international reserves, the CBRT increased
the banks’ transaction limits at the Foreign Exchange
and Banknotes Markets, which are currently 10.8
billion USD, to 21.62 billion USD as of 10 December
2014. Furthermore, the CBRT raised the limits of
export rediscount loans and lowered loan costs on 20
October 2014 to support the balanced growth. These
changes are expected to raise exporters’ borrowing
from the CBRT, which will also lead to an increase in
the CBRT’s FX reserves in 2015.

In addition, it was also stated that it is crucial to
further strengthen the currently robust structure
of the banking sector to enhance financial stability.
Consequently, the CBRT announced on 21 October
2014 that it would provide additional support to core
liabilities to stimulate balanced growth and domestic
savings. To this end, the CBRT decided to remunerate
the Turkish lira component of required reserves
of financial institutions as an incentive, which will
also reduce the sensitivity of the cost of Turkish lira
required reserve holdings against the policy rate and
thus strengthen the automatic stabilization feature of
the ROM.

While the US Federal Reserve (Fed) ended its
quantitative easing program in October, uncertainties
regarding the timing and the magnitude of the
policy rate hike have continued. Meanwhile, amid
weak economic activity in the European Union
(EU) and the growing risk of deflation, the European
Central Bank (ECB) cut the policy rate in this period
and announced a quantitative easing program that
entailed the purchase of covered bonds and asset-
backed securities. In the second and third quarters
of 2014, indicators for global economic activity
performed weaker than expected, causing growth
forecasts for 2014 to be revised down. Financial
market volatility and falling global growth rates led to
some fluctuation in emerging market capital inflows
during the entireyear (Graphs 7 and 8).

To eliminate the possible effects of the excessive
volatility in the FX market on price stability and
financial stability, the CBRT launched unsterilized
FX sales auctions in the third quarter of 2013. These
auctions were held throughout 2014 and total
FX sales of USD 13.08 billion, USD 3.151 billion of
which was made through direct intervention in
January, reduced the CBRT reserves in this period.
Reimbursement of rediscount credits of about USD 13
billion contributed to the CBRT reserves in the same
period.

To support financial stability, the CBRT raised the
reserve requirement ratios of FX-denominated non-
core short-term liabilities of banks and financing
companies in a way to prompt the extension
of maturities in late 2014. The rise in FX reserve
requirement ratios is expected to contribute to
the CBRT’S FX reserves around USD 3.2 billion.
The average FX reserve requirement ratio, which
is currently 11.7 percent, will rise to 12.8 percent.
Moreover, to strengthen the automatic stabilizing
feature of the ROM, technical adjustments were made
in reserve option tranches and coefficients to provide
the FX liquidity due to the adaptations in reserve
requirement ratios.

Due to the uncertainty stemming from the launch of
the Fed’s exit from quantitative monetary easing in
December 2013 coupled with Turkey-specific factors,
the implied volatility of the Turkish lira displayed
a higher increase than those in other emerging
economies in early 2014 (Graph 9 and 10). The
exchange rate volatility, which trended downwards
in the second and third quarters of 2014, trended
upwards again in December 2014.

The Turkish lira and the currencies of other emerging
economies with a high foreign financing requirement
followed a parallel course in 2014 (Graph 11). The
Turkish lira depreciated against the USD by around 9
percent in this period.

The annual growth rate of loans extended to the
non-financial sector, which has been slowing
due to the CBRT’s tight monetary policy and the
Banking Regulation and Supervision Agency (BRSA)’s
measures introduced in the start of the year, recorded
a notable decline in 2014 (Graph 12). This fall was
more evident in consumer loans due to the scope of
the BRSA practices. From mid-2014, the annualized
loan growth rate saw a partial increase on account
of the improvement in consumer loans (Graph 13).
Against these developments, the annual growth rate
of total loans stood at 15.7 percent on 26 December
2014.

Inflation Developments

Inflation, which trended upwards in the first half of
2014 due to the effects of the depreciation in the
Turkish lira since May 2013, assumed a downward
course in the second half and stood at 8.17 percent
at the year end. Inflation realizations remained above
the uncertainty band owing to the exchange rate
pass-through as well as the surge in food prices
resulting from the negative supply shock amid
drought and unfavorable weather conditions. On the
other hand, the plunge in international oil prices in
late 2014 had positive effects on energy prices, which
accelerated the fall in inflation. Due particularly to
the effects of the fall in fuel prices on certain services
items, services inflation registered a decline in the last
quarter of 2014. In addition, amid the alleviation of
the exchange rate effects on the core goods inflation,
core inflation indicators recorded an improvement
(Graph 14). Inflation expectations, which trended
upwards because ofcost shocks driven by the
exchange rate effect and food prices across the year
besides the deterioration in the pricing behavior in
the first quarter, have recently witnessed a recovery
amid the positive contribution of energy prices
(Graph 15).

National Income Developments, Balancing Process
and the Labor Market

The new monetary policy that was adopted at end-
2010 accompanied by the macroprudential measures
ensured a slowdown in domestic demand and
imports, which led to the start of a balancing process
between domestic and external demand. Thus, the
contribution of net exports to growth increased
considerably in 2012, whereas growth stood at 2.1
percent due to the slowdown in domestic demand.
The current account deficit registered a sizeable
decline in the same period. Meanwhile, economic
growth re-accelerated in 2013 and reached 4 percent.
According to the data released by TurkStat, the
annual growth rate in the first quarter of 2014 was 2.8
percent and the mild growth trend was preserved.
The weak course of the final domestic demand (FDD)
and the stronger trend of increase in the exports
excluding gold compared to imports excluding gold
indicate that the balancing process continues (Graph
16 and 17). Thus, the trend of improvement in the
current account deficit was sustained.

The balancing between domestic and external
demand, which started in 2011, brought about an
apparent improvement in the current account
balance as well. Although the current account deficit
saw a deterioration in 2013 due to the rise in net gold
imports, the current account deficit excluding gold
continued to improve gradually. In 2014, not only the
convergence of net gold imports and past averages
but also the deceleration in the rate of increase of the
FDD led the improving trend in the current account
deficit including and excluding gold to continue
(Graph 18). Meanwhile, the new monetary policy
adopted in late 2010 led the real exchange rate to
register a decline that can be considered notable
with respect to economic fundamentals (Graph 19).
The real exchange rate, which depreciated sharply in
the second half of 2013 owing to the uncertainties
regarding the Fed’s monetary policies, assumed a
trend of gradual appreciation as of early 2014. Despite
this development, the average real exchange rate
depreciated by 5.6 percent in 2014 compared to 2013.

In 2014, total and non-farm unemployment rates
displayed an increase (Graph 20). The upward
trend in the labor power increased the non-farm
unemployment rate throughout the year (Graph
21). Non-farm employment receded in the first half
and added to the unemployment rate, but trended
upwards in the second half. Across the sub-sectors of
non-farm employment, following the plunge in the
first half, construction employment partially improved
in the second half of the year. The industrial sector
did not spur an employment increase, while the
services sector drove the rise in employment across
the year.